Financial Accounting · Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Journal Entries and Balance Sheet in Books of Purchasing Company

Updated 10 October 2026 · Fact-checked

When a company buys a partnership business, it records the assets and liabilities taken over, credits the vendor for the purchase consideration, and treats the difference as goodwill (consideration higher) or capital reserve (consideration lower). It then records the discharge of consideration, preliminary expenses, and prepares the opening balance sheet.

Understand Journal Entries and Balance Sheet in the Books of the Company

A company that buys a firm's business is the purchasing company. It does not take over the firm's books. It records a fresh set of entries for what it actually acquires: the assets and liabilities it agrees to take, at the values agreed in the purchase agreement.

The price it pays is the purchase consideration. The company compares this price with the net assets taken over (agreed value of assets taken minus liabilities taken). If it pays more than the net assets, the excess is goodwill, a payment for the firm's reputation and earning power. If it pays less, the shortfall is capital reserve, a gain on a bargain purchase.

The consideration is then settled. It may be paid in cash, in equity shares, preference shares, debentures, or a mix. Shares may be issued at par or at a premium. Under Section 53 of the Companies Act, 2013, shares (other than sweat equity shares) cannot be issued at a discount. Only debentures may be issued at a discount, and the discount is debited to Discount on Issue of Debentures. The vendor's account is closed when the settlement is recorded.

The company also records its own costs. Preliminary expenses (cost of incorporation) are expensed as incurred, so you charge them to the Profit and Loss account. The expenses of share issue may be adjusted against securities premium under Section 52 of the Companies Act, 2013, but only to the extent of the balance in the securities premium account. Any excess, or all of it if there is no premium, is charged to profit and loss. After all entries, you post to ledger accounts and prepare the opening balance sheet in Schedule III format. Take only the assets and liabilities the company agrees to take; anything left with the firm is ignored.

Key rules to remember

Net assets taken over: Net assets = Agreed value of assets taken over − Liabilities taken over; Use agreed values in the agreement, not the firm's book values, if they differ. Exclude assets and liabilities not taken over.
Goodwill: Goodwill = Purchase consideration − Net assets taken over (when positive); Debit Goodwill A/c in the entry for purchase.
Capital reserve: Capital reserve = Net assets taken over − Purchase consideration (when positive); Credit Capital Reserve A/c. It appears under Reserves and Surplus.
Business purchase entry: Assets (each) Dr; Goodwill Dr (if any) → To Liabilities (each); To Vendor / Purchase Consideration Payable; To Capital Reserve (if any); Total debits must equal total credits.
Settlement by shares at par or premium: Number of shares = Amount to be settled in shares ÷ Issue price per share; Credit Share Capital at face value and Securities Premium for the excess. Shares cannot be issued at a discount (Section 53, Companies Act, 2013). Only debentures may be issued at a discount, debited to Discount on Issue of Debentures.
Settlement by shares or debentures: Vendor Dr → To Share Capital; To Securities Premium; To Bank / Debentures; Debit vendor with the full consideration payable.

How to solve Journal Entries and Balance Sheet in the Books of the Company questions

Follow the same order for every question so that nothing is missed and the balance sheet ties.

1Read the agreement and list the assets and liabilities actually taken over, with agreed values. Cross out items left with the firm.
2Fix the purchase consideration as given, or compute it by the method stated (net assets, net payment or lump sum).
3Compute net assets taken over and compare with the consideration to find goodwill or capital reserve.
4Pass the business purchase entry, showing each asset and liability separately, with the vendor credited for the consideration.
5Pass the entry discharging the consideration: Vendor Dr to Share Capital, Securities Premium, Debentures and Bank as applicable. Apply the issue price, any premium on shares, and any discount on debentures.
6Pass other entries: cash raised from public issue, preliminary expenses, and any expenses or commission on issue.
7Post to the Bank account and prepare the opening balance sheet, with equity and liabilities on one side and assets on the other, in Schedule III style.
8Check that total assets equal total equity and liabilities. Any gap shows an error in goodwill or the discharge entry.

Quickest way: Net assets versus consideration check

When to use it: Use when the question asks only for goodwill or capital reserve, or when time is short and you need the balance sheet quickly.

Total the assets taken at agreed values and subtract the liabilities taken.
Subtract this from the consideration. A positive answer is goodwill; a negative answer is capital reserve.
Build the balance sheet directly: equity = shares issued (face value) + premium + capital reserve − preliminary expenses written off (if any); add liabilities taken and debentures issued.
Assets side: assets taken + goodwill + cash balance. Total both sides to confirm they agree.

Common mistakes in Journal Entries and Balance Sheet in the Books of the Company

Using the firm's book values instead of the agreed values.
The firm's balance sheet is given and looks complete.
Fix: Always check the agreement for revalued figures and use those for the company's entries.
Including assets or liabilities not taken over, such as the firm's cash or partners' loans.
Students copy the whole firm's balance sheet.
Fix: Tick only the items stated as taken over. Anything excluded stays with the firm and has no entry in the company books.
Mixing up goodwill and capital reserve.
Students compare in the wrong direction.
Fix: Consideration above net assets means goodwill (a debit). Consideration below net assets means capital reserve (a credit).
Ignoring securities premium when shares are issued to the vendor, or showing a discount on shares.
Students credit Share Capital with the whole consideration, or copy the debenture discount treatment to shares.
Fix: Divide by the issue price to find shares, credit Share Capital at face value and the difference to Securities Premium. Shares cannot be issued at a discount; only debentures can, with the discount debited to Discount on Issue of Debentures.
Treating preliminary expenses as an asset on the balance sheet.
Older textbooks show it as a fictitious asset.
Fix: Preliminary expenses are expensed as incurred. Charge them to Profit and Loss and show them as a reduction in Reserves and Surplus, not as an asset.
Balance sheet that does not agree because the bank balance is not worked out.
Cash from a fresh issue and cash paid to the vendor or for expenses are not combined.
Fix: Prepare a small bank account: add receipts, deduct payments, and carry the balance to the balance sheet.

Worked examples

Example 1

Mehta & Sons' partners agree to sell their business to Aarav Ltd. Aarav Ltd takes over: Land ₹4,00,000, Machinery ₹3,00,000, Stock ₹2,00,000, Debtors ₹1,00,000 and Creditors ₹1,00,000. The purchase consideration is ₹10,50,000, paid ₹50,000 in cash and the rest in fully paid equity shares of ₹10 each issued at par. Pass the journal entries and find goodwill or capital reserve.

Show the solution

Assets taken = 4,00,000 + 3,00,000 + 2,00,000 + 1,00,000 = ₹10,00,000.
Liabilities taken = ₹1,00,000, so net assets = ₹9,00,000.
Consideration ₹10,50,000 is above net assets by ₹1,50,000, so goodwill = ₹1,50,000.
Entry 1: Land A/c Dr 4,00,000; Machinery A/c Dr 3,00,000; Stock A/c Dr 2,00,000; Debtors A/c Dr 1,00,000; Goodwill A/c Dr 1,50,000; To Creditors A/c 1,00,000; To Mehta & Sons (Vendor) 10,50,000. Debits total 11,50,000 and credits total 11,50,000.
Shares to be issued = (10,50,000 − 50,000) ÷ 10 = 1,00,000 shares.
Entry 2: Mehta & Sons Dr 10,50,000; To Bank A/c 50,000; To Equity Share Capital A/c 10,00,000.

Answer: Goodwill is ₹1,50,000. The company issues 1,00,000 equity shares of ₹10 each and pays ₹50,000 in cash to the vendor.

Example 2

Priya Ltd buys the business of Rao & Co. It takes over Building ₹6,00,000, Stock ₹3,00,000, Debtors ₹2,00,000 and Creditors ₹1,00,000. The purchase consideration is ₹9,00,000, discharged by issuing 8% debentures at par for ₹3,00,000 and the balance of ₹6,00,000 in equity shares of ₹10 each issued at ₹12 per share. The company also pays preliminary expenses of ₹20,000 in cash and raises ₹1,00,000 by issuing equity shares of ₹10 each at par for cash. Pass entries and prepare the opening balance sheet.

Show the solution

Assets = 6,00,000 + 3,00,000 + 2,00,000 = ₹11,00,000. Net assets = 11,00,000 − 1,00,000 = ₹10,00,000.
Consideration ₹9,00,000 is below net assets by ₹1,00,000, so capital reserve = ₹1,00,000.
Entry 1: Building Dr 6,00,000; Stock Dr 3,00,000; Debtors Dr 2,00,000; To Creditors 1,00,000; To Rao & Co. 9,00,000; To Capital Reserve 1,00,000. Debits and credits each total 11,00,000.
Consideration to be settled in shares = 9,00,000 − 3,00,000 = ₹6,00,000. Shares = 6,00,000 ÷ 12 = 50,000 shares.
Share capital = 50,000 × 10 = ₹5,00,000; securities premium = 50,000 × 2 = ₹1,00,000.
Entry 2: Rao & Co. Dr 9,00,000; To 8% Debentures 3,00,000; To Equity Share Capital 5,00,000; To Securities Premium 1,00,000.
Entry 3: Bank Dr 1,00,000; To Equity Share Capital 1,00,000 (10,000 shares of ₹10 at par).
Entry 4: Profit and Loss A/c (Preliminary Expenses) Dr 20,000; To Bank 20,000.
Bank balance = 1,00,000 − 20,000 = ₹80,000.
Balance sheet. Equity and liabilities: Share capital 5,00,000 + 1,00,000 = 6,00,000; Reserves and surplus: Capital reserve 1,00,000 + Securities premium 1,00,000 − Deficit in Profit and Loss 20,000 = 1,80,000; Long-term borrowings (8% debentures) 3,00,000; Trade payables 1,00,000. Total = 6,00,000 + 1,80,000 + 3,00,000 + 1,00,000 = ₹11,80,000.
Assets: Building 6,00,000; Stock 3,00,000; Debtors 2,00,000; Cash at bank 80,000. Total = ₹11,80,000. Both sides agree.

Answer: Capital reserve is ₹1,00,000. The company issues 50,000 shares at ₹12 to the vendor and debentures of ₹3,00,000. The opening balance sheet total is ₹11,80,000.

Exam tips

Write the business purchase entry with every asset and liability on its own line. Step marks are given for each correct item.
Show the goodwill or capital reserve calculation as a separate working note, even if the question does not ask for it.
Check that the number of shares comes out as a whole number. If not, recheck the issue price or the split of consideration.
In MCQs, test the direction first: consideration above net assets means goodwill; below means capital reserve.
Present the balance sheet under Schedule III headings and confirm both totals agree before moving on.

Practice questions from Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Journal Entries and Balance Sheet in the Books of the Company in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Journal Entries and Balance Sheet in the Books of the Company: frequently asked questions

What is the difference between goodwill and capital reserve in business purchase?

Goodwill arises when the purchase consideration is more than the net assets taken over. Capital reserve arises when it is less. Goodwill is shown as an asset, and capital reserve is shown under Reserves and Surplus.

Does the purchasing company use the firm's book values?

No. It records the assets and liabilities at the values agreed in the purchase agreement. If no revaluation is mentioned, the book values are used.

How is the vendor's account closed in the company's books?

The vendor is credited with the purchase consideration in the purchase entry. It is then debited when the company issues shares or debentures or pays cash, which clears the account to nil.

How are preliminary expenses shown in the opening balance sheet?

They are expensed as incurred and written off to the Profit and Loss account, so they reduce Reserves and Surplus. They are not shown as an asset.